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Back in June I got an old stink bid filled on Blue Ridge Mountain Resources. It took a while to fill. The stock trades on the grey markets, meaning there is no active bid and ask (at least none that I can see), the security is extremely illiquid and can go for days without trading. You can’t even access the website with their financials and presentations without getting a password from the company, which is why I haven’t written about my position until now. Recently the company uploaded a recent presentation onto their public site, which gives me the opportunity to talk about my position and refer to that.

Blue Ridge Mountain is the post-bankruptcy resurrection of Magnum Hunter Resources. I have had pretty good luck with these sort of post-bankruptcy, grey market situations. Here’s the pattern: I wait patiently to get an order filled at a good price, I wait patiently for the stock to get listed on an exchange where it can get some volume, and then I wait patientlu for it to be revalued accordingly. It doesn’t happen overnight, but more often then not it happens. Most recently, this was a successful strategy with R1 RCM (formerly Accretive Health).

Blue Ridge owns significant assets in the Marcellus/Utica basins in Ohio and West Virginia. They own 77,000 acres in the Marcellus and 109,000 acres in the Utica. Much of this acreage is in the dry gas and gas-condensate sweet spots. Below are maps of their acreage in each basin (Marcellus on the left and Utica on the right):

The company also has a 44.5% ownership in the Eureka pipeline, which is a gas gathering pipeline in Ohio and West Virginia that snakes through the Blue Ridge Mountain acreage.

Blue Ridge has a market capitalization of $450 million at $9/share. At the end of second quarter, as they continue to sell off non-core assets (Magnum Hunter was a bit of a serial acquirer, so Blue Ridge Mountain has a range of assets outside on the Marcellus/Utica that are considered non-core, including some Bakken acreage, some Kentucky acreage, and other real estate holdings), they had almost $100 million in cash. They have no debt.

The Marcellus/Utica Acreage

Forgetting for a second about Eureka, lets just take the Blue Ridge gas assets on their own. Assuming a value on acreage alone, and assuming that about half of that has overlap between the Utica and Marcellus (I have not found any public information that delineates just how much of the Utica and Marcellus acres overlie each other) the stock is trading at around $2,500/acre. Recent transactions in the Marcellus/Utica have taken place anywhere between $5,000/acre and $9,000/acre. Here is a list of recent Marcellus/Utica transactions that I compiled:

The most recent transaction was when EQT Corp acquired Rice Energy for $8 billion. Here are comments on the acreage valuation of the deal and in the area:

Analysts with The Williams Capital Group LP estimated an average price per undeveloped acre for the transaction of $9,900, “which is roughly in line with core acreage valuations over the past year.” Analysts with Bernstein similarly calculated a per-acre price of around $9,000.

Now I don’t think that all of the acreage is worth $9,000/acre. I think that some of the acreage might be worth that though, or at least close to it. The Tyler, Wetzel and Monroe county acreage is all in the same counties as prior transactions, so I would expect it to go in the $4,000 to $8,000 per acre range and some of the Northern most acres might be worth $9,000 or more. Blue Ridge Mountain announced on their first quarter call that they divested a small number of acres (350) in West Virginia for about $4,500/acre.

I’m less sure about the acreage in Washington county, because I haven’t seen any transactions in that area of late. Of course this could be simply because Blue Ridge Mountain owns most of the prospective acres in Washington county (if you study their map you will note their leases cover most of the NE quadrant of the state). They said on the first quarter call that they planned to market the sale of 23,000 non-core acres in the southern part of Washington county in the second quarter. So it will be interesting to get more details on what they can sell that acreage for. They also said they would be drilling a well in Washington county in the third quarter of 2017 and the way they worded it gave the impression this is the first well they’ve drilled there in some time. All of this acreage is within the Marcellus and/or Utica windows, so I doubt that very much of it is going to be worth less than $2,500 per acre. Some of it is clearly worth much more.

Production for the Marcellus/Utica assets was 74MMscfepd in the first quarter. In the second quarter, because of asset sales, natural declines, and the fact that Blue Ridge hasn’t drilled any wells in a year, production had declined to 65 MMscfd.

The company expects to drill 4 Utica wells in the second half of 2017. With production from those wells, exit guidance is to get production back to 100 MMscfd. They described their base rate at between 51-59MMscfepd at year end, meaning that these four wells will add between 30-40MMscfepd. Their base decline is between 12-15%, which is quite low (this is the one benefit you get when you don’t drill any wells for a while). Given the low decline of the base production and the high impact of new wells, its not hard to see how Blue Ridge Mountain can grow production once they start drilling.

On a flowing boe basis, the current market capitalization (ignoring Eureka completely) values them at $32,000 per flowing boe net of cash. That number is much lower if you use exit production guidance. It is also not reflecting what is really valuable; the sizable undrilled land position with no wells on it throughout West Virginia and Ohio.

Eureka Midstream

While a case can be made that the natural gas acreage exceeds the current value of Blue Ridge on its own, there is also the Eureka pipeline to consider. Eureka has been underutilized for the last number of years because of limited takeaway capacity from West Virginia and Ohio. It currently operates at about 30% capacity. Nevertheless, the midstream operation is expected to generate $66 million of EBITDA in 2017. This guidance was reiterated in the second quarter.

Pipeline assets can go for up to 20x EBITDA. At 15x EBITDA Eureka would be worth about $300 million to Blue Ridge.

But there’s a catch. Morgan Stanley has a majority ownership (54%) in the pipeline. But Morgan Stanley also has a preferential return clause for their ownership: the return on their original capital investment is guaranteed a minimum of a 10% IRR in the event of sale. This works out to a preferential return of $672 million if a sale was completed this year. Below I clipped the relevant clause from the bankruptcy documents:

The preferential return clause makes me a little uncomfortable valuing Eureka. Its not clear to me what incentive Morgan Stanley has, as majority owner of the pipeline, to initiate a sale if they can watch their investment grow at 10% annually.

Nevertheless, the pipeline ownership is worth something. In its 2016 year end financials, Blue Ridge Mountain recorded their equity interest at $185 million. This is after a write-down of $180 million that the company took in November 2015.

Obviously, Eureka’s value could increase substantially as new takeaway capacity is brought on to take gas out of the Marcellus/Utica basins, which will allow midstream assets like Eureka to operate closer to full capacity. Blue Ridge Mountain said in the first quarter that they expected Eureka to exit the year with 1.1bcfpd of gas flowing through Eureka, up from 850mmscfpd currently. This 30% increase in throughput should help Eureka get closer to the 10% IRR that is consistent with the Morgan Stanley clause. Assuming a corresponding bump to EBITDA, Eureka would generate $85 million of EBITDA in 2018, which at a 15 multiple would value Eureka at $573 million for Blue Ridge Mountain.

The company has said that they are exploring options with Eureka.

Summing it up

So what’s it all worth? Well there is a lot of uncertainty with the numbers. With Eureka I can get anywhere from $150 million to $600 million. With the Marcellus and Utica assets it could be between $400 million and a billion depending on what you value the acreage at. So its a pretty big range.

But what I feel pretty comfortable saying is that together these assets should be worth more than the current stock price. Maybe significantly more. The hard thing is accumulating the stock. I think you have to just put in a reasonable bid with a long date and wait for it to come to you.

While I have been reluctant to add to any stock right now and have been weighing any purchases carefully, I did add a bit to CUI Global after the release of their second quarter results.

As a reminder, the company operates in two segments. Their Power and Electromechanical segment sells power supplies, power monitoring and interconnect products, and has recently collaborated with a small start-up called VPS Partners to create a technology for datacenter power management called ICE. In the Energy segment CUI Global offers their GasPT gas analyzer system, a newly developed odorizer, VE probes for sampling gas and performs integration and engineering project work.

Segment Results

The company had an improved second quarter, mostly due to the Power and Electromechanical segment. That segment saw a big jump in revenue, from $13.6 million in the first quarter to $18.2 million in the second quarter. The company attributed the jump to an inventory refresh from distributors, a ramp in sales from new distributors, particularly Arrow Electronics, and design wins from 2015 and 2016 that are now ramping into production.

Regarding Arrow, on the second quarter conference call the company said they saw “much more upside” in the relationship with Arrow and that Arrow, which became a distributor early this year, is expanding the CUI Global product line and re-ordering products already.

Revenue continued to lag on the energy segment, coming in at $4.3 million versus $4.1 million in the first quarter. The company remains held up by tariff issues with Snam Rete, which was the first major customer for the GasPT units.

More on Snam Rete

As the company reiterated on the second quarter call, the Snam Rete contract calls for 7,000 GasPT units and is worth €120 million to CUI Global. It’s an extremely significant contract. Snam Rete is installing the GasPT units at the offtakes of major industrial customers, where they will be used to more accurately and quickly measure gas usage by these customers.

CUI Global delivered the first 400 of these analyzers last year before receiving word from Snam Rete that they would not be able to install any more of the units until they received regulatory approval to switch out devices on third party sites. Bill Clough (the CEO) described the issue back on the fourth quarter conference call as follows:

The plan that [Snam Rete] rolled out to install these device is to buy the installation point from these high-end industry customers. Right now where the customer connects to the gas system is currently owned by the customer and due to EU regulations that come into effect next year, the customer has to upgrade that connection, which is going to be quite costly. Snam is offering to buy that connection point from them and to install our device along with some other upgrades that they are going to do including flow computers and other things. And in order to do that they also need to buy an access or an easement to get in and obviously maintain what they are installing.

There is no problem whatsoever if the customer voluntarily agrees to that, which they believe almost all customers will, as obviously they sell an asset that’s going to cost them a lot of money during next year, and so it’s something that becomes a revenue generator as close to cost. However, the energy authority over there says the problem arises with customers who do not want to just pay. Those customers would be paying the same tariff as the customers who do participate, which they felt was a potential anti-trust violation, or what they what they are having to do is, design and implement a two-tariff system, which they have done in the past.

There has been progress on the Snam Rete bottle neck. A few days before the quarter announcement I got an email from a friend pointing to a press release from Snam Rete (here). The release described Snam Rete’s commitment to the “upgrading of measuring systems located at redelivery points of the transportation network through the acquisition of metering systems from final customers”. The press release outlined a €310 million loan from the European Investment Bank that would be used, in part, to acquire these offtakes. CUI Global referred to this press release on their conference call.

Also on the call Bill Clough said that Snam Rete had met with the regulatory authority in June, that the meeting was “productive” and that they expected to here back after the August recess.

The issue with Snam Rete still appears to be a delay, and not a permanent impasse. I would argue that the current share price is reflecting more the latter than the former. Snam Rete’s schedule on deployment is expected to require 100 analyzers a month. At €17,000 per analyzer, resumption of this contract alone would more than double Energy segment revenues. That positive outcome is just not priced in at a $3.50 stock price.

Odorization Orders

The Snam Rete press release linked to above also describes a commitment to the “installation of odorization systems for industrial final customers”. This is referring to the purchase of CUI Global odorizer product, which is a product that simply mixing in an odorizing chemical with otherwise odorless natural gas. CUI Global licensed the technology from Engie at the same time that they entered into the relationship with them.

On the call management said that Snam Rete is looking at purchasing 1,300 of the odorizers. They said Engie is also looking at deploying the odorizers throughout their system. CUI Global said on their first quarter call that odorizers would sell for €7,000 to €10,000. The odorizers are still in the beta phase of development but they are proceeding to field trials (with Snam Rete) in September.

Other GasPT orders

CUI Global is making progress with Engie as well as in North America with a pipeline company in Alberta (TransCanada?).

Regarding Engie, CUI Global submitted a bid on 1,000 GasPT units and 1,000 remote terminal units (RTUs) to be installed by Engie’s subsidiary Endel. They said on the call that they are the only bidder, and they that have already been spec’d in on the design. The per unit revenue for the analyzers is in the €17,000 to €20,000 range, and there is similar pricing on the RTUs. So again, another big opportunity.

In Canada, the company has had their previous Italian testing approved by Measurements Canada, which leaves a final step of a 3 month installation test on a Canadian pipeline. This is expected to begin in September.

Future Billing Contract

This is a contract with DNV GL to explore the potential of using GasPT units to monitor the delivery of biogases into the delivery system. The project is in the early stages and won’t result in revenue until 2019 at the earliest. However it could have big implications if it concludes favorably. Clough said that if the project is approved and deployed across the network (the UK) it would require in the range of 45,000 GasPT units. If adopted in other European countries (France, Germany, the Norwegian nations), a similar magnitude of units would be required for each country. Keep in mind the Snam Rete contract, which is extremely significant in its own right, calls for 7,000 GasPT units.

ICE Technology

The last data point that I will touch on is the ICE technology. As I mentioned above, this is a partnership with VPS to provide a power optimization solution for datacenters. CUI Global provides the hardware while VPS has developed the software.

On the second quarter call for the first time management gave a bit more color around the opportunity.

There “is no competing technology in terms of doing peak shaving” to ICE. The return on investment by implementing an ICE system is significant, as it can unlock 10% to 20% of power capacity.

So far beta and sampling testing have reported good or better than expected results. They expect small, immaterial revenues in beginning in the fourth quarter. This will be followed by a pick-up in 2018 and adoption (assuming it occurs) in 2019.

They delineated the revenue opportunity based on data center size. The smallest scale centers are $750,000 opportunities, the average datacenter is a $2 million opportunity, and the largest scale datacenter is $30 million opportunity.

The overall total addressable market (TAM) is estimated at $700 million to $1.5 billion for North America and 5x that for the rest of the world. I suspect that these numbers are for the entire ICE product. As CUI Global delivers only the hardware, and I get the sense that the innovation is really the VPS software, their fraction of the TAM is likely quite a bit less than the total. Nevertheless, it’s a big market for a little company. They said that in the mid-term they could see revenue ramping to a few million per quarter and in later years with scaled adoption it could be as much as $15-$20 million.

Overall

At $3.50 CUI Global has a market capitalization of $75 million. Net debt is about $4 million. They plan to raise about $4 million cash from the sale of their Washington facility. That cash influx, combined with the better outlook from both the energy and electromechanical segments has led them to cancel the at the market (ATM) share program. I think a lot of investors looked unfavorably at the ATM program, particularly the uncertainty as to whether the company was helping to beat down its own stock over the last few months (they weren’t).

At the current market capitalization the company trades at 1x revenue. Given the opportunities outlined above, I think its still a reasonable bet, which is why I added a little last week.

I am back from vacation and will be providing a few updates over the weekend of what I have done lately in my portfolio.

I will start with Aehr Test Systems.

I am reluctant to add to any position given the market. My investment portfolio cash position is up to 65%, and is even higher (83%) in my RRSP account. Nevertheless I did add to my position in Aehr Test Systems.

I’ve been waiting on a retracement in Aehr for some time. I think that under $3 is a good opportunity to buy the stock. On July 19th the company announced earnings. Their fourth quarter revenue, at $6.7 million, beat their own $6 million guidance. Their current backlog is $17.8 million (including the $1.3 million WaferPak order announced on August 9th), which is almost equal to full year revenue from the previous year ($19 million). On their fiscal fourth quarter conference call the company said they expect to “exceed” 50% revenue growth in the next fiscal year.

Listening closely to the conference call, it is clear that the upside bound on revenue could be much higher. There are a number of high volume applications for their test systems that Aehr is being integrated into and where purchase orders are anticipated. I think its possible that we see a press release event where a large (maybe $10 million plus?) order is announced. This would send the stock up significantly.

But of course I’m a little worried about the recent weakness in the stock. Catching a falling knife is never advised and that is what I have done here. But there have been so many instances of small caps nosediving only to recover the last couple of months that I suspect this is just another one of those. I think back to a number of stocks that I have owned, Novabay Pharmaceuticals for instance, which had precipitous drops that were followed by recoveries. There was some insider selling after the move to $4, so perhaps some investors have taken that as a cue to sell. The stock is so illiquid that it only takes one large, dedicated seller to send the stock down.

One the negative side they sell semi-conductor equipment, which is a lumpy and cyclical business. Interestingly, on the last conference call management said that they are still too small to be caught up in the cycles.

We are not necessarily dealing with macro semiconductor cycles here yet. As we are primarily designed in on key new programs with our customers with new products and new applications in many cases, and so it’s very specific to those customers

I note that the other equipment manufacturer I follow, Ichor Holdings, had a dip back at the beginning of August but has stabilized of late.

After the move down the stock trades at a market capitalization of $55 million. After the recent capital raise there is $18 million of cash on the balance sheet and no debt. Assuming 50% revenue growth in fiscal 2018, the stock trades at about 1.3x revenue.

Thoughts and Review

I have been on vacation on and off since the beginning of July, so my posting has been sporadic. I should get more regular again in my posting by the end of August. I don’t have good internet access and so I won’t be posting my updated portfolio until I get back.

I wrote a few weeks ago about my thoughts on the Canadian dollar. At the time, I was frustrated by the move but I did not see a fundamental reason for it to continue. I therefore concluded that I was comfortable holding onto my US dollar stocks and maintaining my US dollar exposure.

That turned out to be a poor decision.

The Canadian dollar has continued to rise. Its not the only currency to do so. I see similar moves from the Australian dollar, the Euro, etc. What we are seeing is broad based US dollar weakness.

Since that time I have become worried that what is happening has nothing to do with Canada. I’m worried that the strength of the Canadian dollar is because of a growing recognition of just how bad the US government is. That there is significant dysfunction that goes much deeper than the circus we see on CNN and Fox News.

There was an article published this week in Vanity Fair by Michael Lewis (the author who wrote Moneyball and The Big Short). In it he describes the transition from the Obama administration to the Trump Administration at the Department of Energy (DOE). Basically, the Trump team was uninterested in learning about the department, made no effort to replace key positions, and even 6 months into the administrations tenure many appointed positions have been left unfilled and policy directions unsaid. The DOE, to put it bluntly, is running on fumes.

If this is representative of how the Trump administration has approached governing as a whole, it suggests a large degree of dysfunction. Dysfunction that is deeply rooted into the core of the government departments that run the operations of the country. Who knows what this will lead to. It certainly does not give confidence in the country as a whole.

I remember that one of the things that Donald Coxe used to talk about was how you can’t have a strong currency with a weak government. Much of his assessment on the direction of a country’s currency was based on the political climate of the country.

We know that on the surface, the Trump administration has proven to be reality TV. But maybe behind the scenes things are actually worse. If it is much worse, then maybe the currency moves over the last few months are just the beginning. This move in the Canadian dollar is notable for its strength. It does not want to quit. I have learned that ignoring a very strong move in an asset class is unwise. It is often brought about by seismic shifts to the economic landscape that are fully understood only after the fact. I’m really worried that is what is happening here.

I regretfully reduced my USD exposure yesterday. I sold down a number of US dollar positions and converted those US dollars into Canadian dollars. I didn’t sell out of any position because there is nothing wrong with any of the stocks I own. So I reduced everything across the board so that I could turn those US dollars into Canadian dollars. The process was depressing.

I’ve always held the rule that if my portfolio falls 10% from its peak I will start to significantly reduce my exposure. This is my “2008 rule”. I won’t let 2008 happen again. In 2008 the first 10% down was followed by another 10% and so on and so on. Before I realized what was going on it was too late. To prevent this, I decided that at 10% I draw a line in the sand.

I have held to this rule a few times over the last few years. In 2014 when I was getting killed on oils. In January 2016 when I was getting killed on everything.

What is unique about this time is that its almost all currency. I’m down 9.5%, but a little over 7% of that is the Canadian dollar. Its depressing to see most of my stocks holding their own at levels similar to where they were 2.5 months ago and yet my portfolio is down significantly from that point.

But 10% is 10% and I have to do something about it. So I sold it all down.

Air Canada Earnings – out of the park

Air Canada released second quarter results this morning and they were well above anyone’s expectations. The company blew away second quarter EBITDA estimates, guided gross margins higher, and guided free cash flow for 2017 of $600 million to $900 million. The free cash flow guidance is up from previous guidance of $200 million to $500 million. Air Canada has a market capitalization of a little over $5 billion, so the new free cash flow guidance means that the stock is trading at 7x FCF based on the new guidance.

Combimatrix Takeover – finally some positives!

Its been such a frustrating couple of months. The Canadian dollar has been on an unstoppable march upward. My moves into oil and gold to hedge the exposure have had mixed results at best. Radisys laid an egg. But things took a big step in the right direction tonight as Combimatrix has been taken over by Invitae Corporation. From the news release:

Based on the Company’s current forecasts and estimates of Net Cash, and based on a fixed price per share of Invitae’s common stock of $9.49, the Company presently estimates that the CombiMatrix price per share received by CombiMatrix common stockholders would be between approximately $8.00 and $8.65.

This was a much needed win. Combimatrix was one of only a few US stocks that I didn’t reduce over the last few weeks. I’ve yet to sell my shares here. I may start to reduce them as they get to $8.

Radisys lays an egg

Radisys reported and it was not good. My thoughts are: A. I’m glad I sold down my position as much as I did, B. I’m less glad that I bought a little back a few days ago, and C. I’m wistful that I just would have sold the whole block back when they lowed guidance at the beginning of July.

Radisys reported second quarter earnings last night and the guidance for the third quarter was worse than the second quarter. Verizon has stepped back from DCEngine purchases for 2018 because of changes they have made to their subscriber structure that has pushed off requirements for more capacity.

Listening to the call, apart from the revenue headwind that occurs when your largest customers steps back for 6 months, the company moved forward in all other respects. They are seeing a material increase in engagements around CORD (central office as a data center), shipped for lab trials to a US Tier 1 which presumably is AT&T, closed on the “master purchase agreement” with the Tier 1 (again I assume AT&T) that they had alluded to in May, they were named systems integrator for a Tier 2 service provider in Europe, and they launched the new FlowEngine TDE and already have had a win with it in Europe. Overall they are up to 15 proof of concepts which is 5 more than they were engaged with in the first quarter.

But none of this is revenue generating in the immediate future.

I held onto Radisys too long. I’m generally good about selling a stock that isn’t working but in this case I was enticed time and again by the promise of a better future. I don’t think that Radisys management was being deceitful, I just think that being telecom equipment manufacturer is hard. I listened to a podcast of a seasoned telecom analyst who said as much. You get one time orders, nothing is recurring, and you are dealing with big, lumbering beasts of telecom companies that can move at a glacial pace and do not care how their erratic decisions impact you. Radisys is a casualty of this dynamic. I sold.

Selling Radcom

I also used the bump back over $21 in Radcom to sell it down further. I had been selling down Radcom over the last couple weeks. I have completely sold out of the stock in one of my portfolios and own a mere shadow of the position that it used to be in the other.

My thoughts on Radcom are related to valuation and timing. I’m worried about the market, and stocks that trade at extremely high price to sales ratios are particularly susceptible in corrections. Radcom reports earnings on August 7th, and I don’t expect that they will have any new contracts in place at that time. I wonder what happens to the stock if their next NFV win is delayed into the fourth quarter and in the mean time the market slides. I’ve decided I prefer to be on the sidelines to watch if that event plays out.

Empire Industries

I will write something more extensive on Empire’s quarter when I am back but the bottom line is that I am happy with it.

On the surface the lower sequential revenue, lower sequential EBITDA, is probably the cause of recent selling but I see a number of positives in the quarter that bode very well for the future.

First, the company generated over $6 million in operating cash flow, including cashing in $4 million from working capital.

From what I see, they paid down about $6 million of debt in quarter! I added up the numbers twice because it seemed like so much but if you add up bank debt and long-term debt it decreased substantially quarter over quarter.

Deferred revenue increased substantially from $10 million to $23 million sequentially. This is related to the big working capital influx. Revenue should follow shortly imo.

I don’t see how you can view the growing backlog as a negative. This is a construction business, size of backlog is directly related to future work. The doubling of the backlog is a huge positive imo.

Keep in mind this is a ~$40 million market cap company that just generated $6 million of operating cash flow for the quarter, roughly $5 million of free cash flow, and has doubled their backlog.

Hudson Technologies

Hudson was a mixed bag. They had a blow out quarter. But they forecast weaker volumes and prices for the third quarter. They also made a huge acquisition, of Airgas-Refrigerants. I honestly had trouble wrapping my head around all the data points, especially with limited internet and time, so I sold.

Hortonworks

Hortonworks had a blow out quarter and gave solid guidance. The stock rose significantly, which was nice. I sold out after the jump, which had more to do with my market outlook than any insights with the company.

Vicor

Vicor had a wait and see quarter. Revenue, bookings and backlog were all up, but less than I would have liked them to be. But the company forecast a much better third quarter and reiterated their guidance for a $75 million run rate by year end. I still really like the stock and it is on the of the few I hold in size.

What’s Left

The only positions that I have right now that are greater than 2% position in the portfolio are the following: Vicor, Combimatrix, Air Canada, Empire Industries and Americas Silver. Every other position I own is less than 1%. That kind of sums up where I stand right now.

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